National Bank Appeals Process:
Appeal of a Shared National Credit - (First Quarter 2005)

A bank appealed to the ombudsman a decision rendered by the Shared National Credit (SNC) Interagency Appeals Panel in July 2004.  Initially, the SNC review team rated as substandard and nonaccrual two priority lien credit facilities secured by an assignment in an equity interest in the assets of two bankrupt commercial projects.  Additionally, there was a guaranty from the parent company for an equity commitment to complete construction of the projects.  The bank ap­pealed the nonaccrual designation on both facilities to the SNC appeals panel.  The SNC appeals panel determined that the bankrupt projects, including the priority lien credit facilities should be classified as "other assets," and the remaining unsecured portions of debt classified as loss.

In December 2002, the lender groups assumed effective control of the two projects by replacing management, obtaining the rights to sell the projects, and actively marketing the plants for sale.  (The guarantor for equity to finish these projects had previously experienced severe financial difficulties, abandoned support of the projects, and filed for bankruptcy protection.)  Consequently, both the primary and secondary repayment sources were in jeopardy.  The appeal states that the bankruptcy court has recognized the obligations of the guarantor, and they are subject to claim by the unsecured creditors.  The appeal also states that there is a second­ary market for these bankruptcy claims that precludes a full loss classification.

Discussion

The bank agreed with the classification of the affected credits as "other assets," however, it disagreed with the loss classification, and submitted an appeal to the ombudsman.  According to the appeal, the bankruptcy documents supported that there were assets available to provide some relief to the unsecured creditors.  The bank further cited inconsistent treatment among the SNC review teams in the classification of these credit facilities at other banks.  Specifically, there were two other agent banks designated as unsecured creditors by the bankruptcy court, yet the SNC review teams at those banks gave value to varying degrees the underlying assets supporting the bankruptcy claims.

Management's view was that since the unsecured facilities would be treated equally in bankrupt­cy, they should be treated similarly in the SNC evaluation process.  The fair value of the underly­ing assets should include value given to the bankruptcy claim on the underlying assets.

The new SNC interagency review team was convened in November 2004.  In the time period between the initial SNC review and the review by the new SNC interagency review team, the guarantor emerged from bankruptcy and the lending group signed contracts for the disposition of assets. Consequently, the credits were reviewed in November 2004, based on this later informa­tion rather than the bankruptcy status at the time of the initial review, which would be the tradi­tional approach employed in the appellate arena.

The SNC interagency review team concluded that credit factors were substantively unchanged from when the guarantor originally filed for bankruptcy, and insufficient to maintain carrying the exposed portions of the facilities dependent on its guaranty in the active loan portfolio.

Conclusion

Critical to this evaluation is the determination of whether the obligation under this guaranty was, and should remain, a "bankable asset" (as referred to in the interagency definition of loss[1]).  This does not mean the obligation has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off a basically worthless asset even though partial recovery may result in the future.  In this assessment, credit factors should be present that provide assur­ances that the obligation is reasonably well secured and if not, at least in process for full collec­tion with imminent closure expected. These are necessarily high standards because the obligor is in default and under the control of the bankruptcy court. The claim is unsecured, and the lenders were not entitled to adequate protection payments or any other regular distribution from the bank­ruptcy estate that might be considered interest income.  The total unsecured claims against the bankruptcy estate, of which the bank group was a part of, substantially exceed estimated recover­able amounts from a potential sale of the operating assets of the guarantor.  These factors do not provide adequate support for the bank group's portion of these claims to remain indefinitely in the active portfolio, even when charged down to estimated recoverable amounts.  The foreseeable events, since the guarantor filed for bankruptcy, held considerable uncertainties for those esti­mated recoverable amounts, and their unfolding in recent months does not obscure the fact that collection efforts were best characterized as recovery.

Thus, the classifications of the assignment of the equity interest in the commercial properties as "other assets" were upheld.  Any remaining balance was deemed a recovery matter and directed to be charged off.  However, since collection efforts were already in process, the banks were allowed to charge-off the losses consistent with the closing of the sales contracts scheduled for the upcom­ing quarter following this review.  This decision was confirmed by the ombudsman and applied unilaterally to all banking groups.